An energy crisis precedes a cash crunch, Zambia’s 2015 deja-vus scenario

Once upon time 4 years ago, Zambia was in a very similar energy quagmire which I dub the Kariba crisis measuring 900 MW. Load management was rampant between 6-8 hours plugged by power imports from Mozambique’s EDM and South Africa’s Eskom. All these options to maintain power stability cost the fiscals $10million a week. This scenario let to the acceleration of completion of the Maamba 300MW geothermal and Itezhi Tezhi 120MW plants. Over dependence on hydro for power generation with very minimal attention to diversification is one of the key reasons Zambia has struggled to manage power deficit scenarios.

Kariba crisis, currency roil and inflationary effects: This power crisis coincided with China lifting the peg on the Yuan which saw it slide 2.3% causing a roil in emerging market currencies, the Kwacha inclusive. Falling reserves and general economic turbulence and fiscal pressure sent the Kwacha to record lows of 14.2 for a unit of dollar fueling double digit inflation. Consumer price index doubled to 14.3% in September 2015 from 7.4% which rallied further to 19% in October after closing the year at 22.3%. Speculation was prevalent as all in the business chain attributed prices hikes to dollar scarcity hence fueling cost push inflationary pressure.

Monetary policy tightening: The central bank was accused of being passive after waiting for November Monetary Policy Committee (MPC) meeting to hike its benchmark interest rate 300 basis points to 15.5% the highest the BOZ has seen in history. This move was to curb a currency slide. The MPC added a 1,000 bps above the MPR of 15.5% to 25.5% on emergency funding to commercial banks overnight while restricting access to the window to once a week. This move sucked liquidity out of the system after the Statutory Reserves Ratio (SRR) hiked to 18.5%.

Genesis of expensive deposit era: Because of a higher cost of funding and the cash crunch surplus units such as pension funds earned exorbitant margins on fixed deposits to between 28% in the 1yr and 35% in the 2yr tenors. This was the genesis of the expensive deposit era that took over 2-3 years to flash out of commercial banks balance sheets. Smaller banks were desperate for deposits to operate and as such the media was flooded with attractive fixed deposit rate adverts. In fact flashy adverts for too good to be true yields on fixed deposits are signal of liquidity problems commercial banks may be facing. The winning banks in this era where those whose payment platforms are efficient.

The currency did stabilize: This worked well for currency stability but ebbed the cost of funding higher while paralyzing private sector growth in 2016 to 3.22% compared to 6.7% in good years. Foreign currency trading in 1H:16 was suppressed with the central bank dictating bid offer spreads to the extent that the market was moved by small lots such as $100k. Zambia’s exchange rate regime is a free foot but regulation dictating bid – offer spread was not a welcome move by traders as it’s contradicts the free float regime requirements.

Private sector pulse was paralyzed: Zambias private sector pulse as measured by Purchasing Managers Index (PMI) had significantly weakened in the period given an elevated cost environment given extended load management as a result of lower than usual water levels at the Kariba and other water bodies. November 2015 vs 2019 PMI was 41.5 vs 48.7 ( 50 is the borderline of contraction and expansion).

Four years later today in 2019, the currency has slid 22%, lower than the 2015 levels at 15.67 for a unit of dollar. The central bank in its November MPC only hiked rates 125bps to 11.5% (400bps lower than the highest ever seen). This could suggest the BOZ has latitude to widen the policy rate if it so wished but for the depressed growth environment Zambia faces. Inflation headlined 10.8% in November (820bps lower than 4 years ago). Even after a hike in rates to 11.5% and an upward adjustment to the overnight lending facility to 28% (1,000bps higher) the Kwacha still continued to slide as dollar demand persists. The major differences in events between the 2019 crisis and that of 2015 is that debt service obligation is higher currently than previously. Foreign exchange reserves have halved to $1.45 billion compared to $3.8billion in 2015 same period.

A dejavus experience: In the last few weeks to yearend, markets wait to see if the central bank will act to hike statutory reserves to tame a currency that is pointing north approaching 16 this week. Will inflation jump to unprecedented levels in December as CPI prices in currency weakness and energy crisis autopsy effects?

Written by Mutisunge Zulu a Financial Analyst and currently serving as National Secretary of the Economics Association of Zambia.